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Market Calm Remains Intact 

Treasury yields and the broad dollar are coming under selling pressure ahead of this morning’s inflation report, but position-taking looks relatively subdued. The report, due in less than half an hour, is expected to show the core consumer price index rising by 3.8 percent in the year to December, slowing from 4 percent in November and helping set the stage for rules-driven rate cuts from the Federal Reserve in the coming months.

As we had suspected, Federal Reserve Bank of New York President John Williams attempted to rebuff these easing expectations in a speech yesterday, but markets paid him little heed. “We have seen meaningful progress on restoring balance to the economy and bringing inflation down,” Williams said, but “I expect that we will need to maintain a restrictive stance of policy for some time to fully achieve our goals, and it will only be appropriate to dial back the degree of policy restraint when we are confident that inflation is moving toward 2 percent on a sustained basis”. Odds on a cut at the central bank’s March meeting are hovering near 70 percent, and investors see the Fed Funds Rate falling by least 143 basis points this year, effectively unchanged from yesterday morning’s levels.

Oil prices are higher after an oil tanker was boarded by unknown parties – possibly Iranian forces – off the coast of Oman. According to a report this morning, at least one Royal Navy ship resorted to using its Oerlikon close-range anti-aircraft guns to down Iranian designed and funded Houthi drones earlier this week, suggesting that the risk of an impact – and an ensuing escalation in tensions – is significant. West Texas Intermediate is trading hands for more than $72 a barrel, while Brent is going for around $78.

The euro is trading near the psychologically-important 1.10 handle against the dollar, and could push through on a softer US inflation print. Investors are broadly repricing European Central Bank rate cut expectations in response to relatively-hawkish commentary from several officials, with Vice President Luis de Guindos calling the labour market “particularly resilient” and saying that he expects inflation to firm in the early new year. Executive Board member Isabel Schnabel again warned that “it is too early to discuss rate cuts” with “additional data confirming the disinflationary process” needed before easing could be considered.

THURSDAY

Markets are braced for a modest re-acceleration in US headline inflation in December’s data, with the month-over-month increase in prices moving up to 0.2 percent from 0.1 percent in November. Higher gasoline costs are seen pushing annual price growth to 3.2 percent from 3.1 percent prior, but the core basket should slow to 3.8 percent from 4 percent prior. An above-consensus print could force markets into lowering the number of rate cuts expected over the next year, while a weaker number might drive a doubling-down on the “soft landing” thesis that lifted global asset prices in November and December. (08:30 EDT)

FRIDAY

The British economy is seen bouncing back from October’s -0.3 percent contraction in November, but a modest 0.2 percent gain is unlikely to fully offset recessionary risks. Signs of improvement are appearing – consumer confidence and retail sales have risen in recent months, and purchasing manager surveys are pointing to a stabilisation in business investment – but output may have shrunk another -0.1 percent in the fourth quarter of 2023, and could remain in contractionary territory for months yet. If inflation follows current consensus in falling precipitously, the Bank of England is likely to begin a rhetorical pivot imminently. (02:00 EDT)

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Higher for (even) longer